How have you seen warranty and indemnity insurance being used since the onset of the pandemic last March, and how many secondaries deals have you worked on where it was used since then?
W&I insurance (or representations and warranties insurance as it is known in North America) has been increasingly used on secondaries transactions as GPs and LPs seek new ways to protect themselves against potential liabilities, provide deal certainty and facilitate transactions by utilising insurance capital as collateral for recourse. The outbreak of the covid-19 pandemic led to a surge in GP-led transactions and this in turn saw a surge in demand for W&I insurance to facilitate these deals.
The use of W&I insurance on secondaries transactions isn’t an entirely new phenomenon. However, the pandemic definitely accentuated the use of the solution. Furthermore, better understanding of the transaction dynamics and the information that is typically available has helped to ensure that W&I insurance provides a robust solution. We estimate that in 2020 about 20-25 secondaries transactions used W&I insurance (both in Europe and the US), of which we acted on four last year.
In what types of transactions have these typically been used, and what are some of the key considerations?
The use of W&I insurance has typically been centred on single-asset and concentrated portfolio continuation funds, as many GPs decided it was prudent from a portfolio management perspective to extend the duration of a fund structure and raise additional capital to be offensive during the period of dislocation and expected recovery. While the W&I insurance product is effectively the same on secondaries transactions as it is on buyout transactions, the underwriting process is different owing to the lighter diligence commonplace on secondaries transactions. Certain specialist underwriters have adapted their underwriting process to focus their review on governance and controls at the fund instead of requiring voluminous and expensive due diligence, which was historically proving to be an obstacle in getting these deals insured.
Walk us through a case study of when W&I was used. What issues did it address for the parties involved in the transaction?
We recently put a policy in place where a GP was seeking to access the secondary market to capitalise a continuation fund. The GP’s advisors contacted us as it was planning the sale of a portfolio of assets from an existing fund into a continuation fund in order to extend the investment cycle of the portfolio. The continuation fund had a combination of new and some rollover LP investors who were seeking additional warranty protection in relation to the underlying portfolio.
The continuation fund took out a ‘buy-side’ W&I policy which covered a suite of operational and business warranties in addition to title and capacity warranties. This thereby allowed the existing fund a ‘clean exit’ with a £1 ($1.37; €1.15) financial cap, which meant they could release capital for all investors in the fund without threat of a call on the capital in the event of a claim for breach of warranty and allow them to eventually collapse the existing fund structure.
How much does W&I insurance typically cost, and who bears the cost?
Rates differ between European and North American transactions. Typically, W&I insurance for a UK/European GP-Led secondary transaction would be priced at around 1 to 1.5 percent of the limit of liability under the policy insured. For North American deals (where the product is known as R&W insurance), pricing is about 2.5 to 3 percent of the limit of liability under the policy insured. One typically buys somewhere between 10 and 30 percent of the transaction value as the limit of liability under the policy. In some instances, one can purchase fundamental cover (ie, title and capacity) to the full transaction value. This is available at a much cheaper premium, about 0.1 to 0.5 percent. In addition to the premium, there are underwriting fees that need to be covered off. In most cases, the cost of the policy is borne by the GP.
How is W&I insurance evolving in relation to the single-asset GP-led market? What’s the future for its use?
The W&I insurance market may evolve so that underwriters provide a suite of standard warranties to be used on secondaries transactions (instead of warranties having to be negotiated and agreed), facilitating efficient and cost-effective transactions whilst maintaining liability protections for investors and GPs. Additionally, some aspects of excluded obligations can now be covered, which is an exciting development for the market.
Tan Pawar is managing director of BMS’s Private Equity, Mergers & Acquisitions and Tax Insurance division, while Harry Leitch director and head of origination. BMS is a global broker that provides specialist insurance, reinsurance and capital markets advisory services.